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4000 - Advisory Opinions
Interpretation of Regulation O with Respect to a State Chartered
Non-Member Bank's Sale of Real Property to an Unrelated Third Party
FDIC--94--5
January 14, 1994
Sandra Comenetz, Counsel
This responds to your letter of December 10, 1993 to Pamela LeCren
of this office concerning the FDIC's interpretation of Regulation O, 12
CFR §§ 215.3(a)(5) and 215.3(f). 1
You state that the chairman of a state chartered non-member bank
sold real property to an unrelated third party who is not an insider or
affiliate of the bank. The chairman financed a portion of the purchase
price, evidenced by a promissory note and secured by a real estate
mortgage. The bank wishes to make an extension of credit to the
non-insider. You ask the following questions:
(1) Assuming such an extension of credit met all of the bank's
credit underwriting standards, was made on market terms, complied with
applicable loan to value ratios, and that the chairman would have no
further interest in the extension of credit either directly or
indirectly, may the bank purchase the note and mortgage from the
chairman?
(2) If the answer is that the bank may not purchase the note
and mortgage, may the bank originate a new loan to the non-insider
which would be evidenced by the bank's own original note and mortgage,
and which, in effect, would refinance the existing indebtedness to the
bank's chairman?
(3) Does 12 CFR § 215.3(f) prohibit the bank from making
original financing to purchasers of assets from bank executive officers
on market terms and in compliance with the bank's underwriting
standards if such extensions of credit exceed $100,000 for any
executive officer/seller?
The following first responds to your questions under the FDIC's
interpretation of Regulation O in its present formulation. However, as
you mention, the Federal Reserve Board has issued a proposed amendment
to Regulation O (58 Fed. Reg. 47400 (Sept. 9, 1993)), which,
if adopted in final form, could affect the FDIC's current
interpretation of the rule, particularly as it applies to the issues
you raise. With that in mind, we have also analyzed your questions in
light of that proposal.
Concerning your first question, under the FDIC's present
interpretation of 12 CFR § 215.3(a)(5), the bank's purchase of the
note and mortgage from the chairman, i.e., a "discount of
a promissory note", would constitute an extension of credit to the
chairman, and, as such, have to meet Regulation O requirements.
As to your second question, under the FDIC's present interpretation
of 12 CFR § 215.3(f), if the bank originates a new loan to the
non-insider, that would constitute not only an extension of credit to
the non-insider, but also to the chairman because the
{{8-31-94 p.4833}}proceeds of the extension of credit to
the non-insider will be transferred to the chairman. Such a transaction
would have to meet Regulation O
requirements. 2
The answer to your third question is that under the FDIC's present
interpretation of 12 CFR §§ 215.5(c) and 215.3(f), original
financing to purchasers of assets from bank executive officers that in
the aggregate would exceed $100,000 would be prohibited.
Regarding your first question, if the Federal Reserve's proposal is
adopted, arguably the bank's purchase of the note and mortgage from the
chairman would not constitute an extension of credit because the
proposed rule does not treat transactions involving discounted
promissory notes as extensions of credit.
Concerning your second question, because the Federal Reserve
proposal excludes from the tangible economic benefit rule arms-length
transactions to finance the bonafide purchase of property from an
insider, the bank's origination of a new loan to the non-insider would
not constitute an extension of credit to the chairman, and therefore
would not have to meet Regulation O requirements.
As to your third question, under the Federal Reserve proposal
insofar as original financing to a non-insider for the purpose of
purchasing property from an insider is excluded from the operation of
the tangible economic benefit rule as noted above, such financing,
regardless of the amount, would not be prohibited.
We trust the foregoing responds to your inquiry. Thank you for
writing to the FDIC.
1Sections 215.3(a)(5) and 215.3(f) provide:
(a) An extension of credit is a making or renewal of any
loan, a granting of a line of credit, or an extending of credit in any
manner whatsoever, and includes:
* * * * * *
(5) A discount of promissory notes, bills of exchange, conditional
sales contracts, or similar paper, whether with or without recourse;
but the acquisition of such paper by a member bank from another bank,
without recourse, shall not be considered a discount by the member bank
for the other bank;
* * * * * *
(f) An extension of credit is considered made to a person covered
by this part to the extent that the proceeds of the extension of credit
are used for the tangible economic benefit of, or are transferred to,
such a person.
Regulation O was promulgated by the Federal Reserve Board
and was made applicable to insured nonmember banks by section 18(j)(2)
of the Federal Deposit Insurance Act (12 U.S.C. § 1828(j)(2)). Go Back to Text
2The FDIC has had occasion to adopt a less strict
interpretation of the tangible economic benefit rule. We have
distinguished situations where third parties have used bank loans to
purchase from a bank insider consumer goods and services from
situations in which proceeds of a loan are used to pay the interest
and/or principal owed by a covered person to the bank or where proceeds
of a loan are used by the debtor to buy out the interest of a covered
person in a venture. FDIC Interpretive Letter 89--36 (Oct. 30, 1989).
This exception has been applied only to isolated consumer purchases
where the loan was extended on an arms-length basis (e.g.,
the insider did not arrange the loan), the loan conformed to safe
and sound banking practices, and the borrower was creditworthy. The
rationale for this approach is that under Regulation O, such isolated
consumer transactions should not be discouraged. Go Back to Text
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